Introduction
Investors are always looking at various indicators to inform them on whether to invest in a company. One calculates these indicators from the company’s financial statements. Ratio analysis is performed to determine the health of the company; there are many types of ratios. One class of ratios is called liquidity; examples include current ratio and quick ratio. Liquidity ratios tell the liquidity position of a company. Another type of ratios is the solvency ratios which determine if a company can settle their long-term debt obligations. Examples of solvency ratios include debt-to-equity ratio, interest coverage ratios, and debt to asset ratio.
Profitability ratios are a class of ratios that tell a company’s ability to generate income from the existing capital. Examples of profitability ratios include gross profit margin, return on equity, return on assets, and net margin. Valuation ratios are a class of ratios that analyze a listed company’s stock price, whether it is valued fairly and whether to buy, sell, or hold. Valuation ratios include price to earnings (PE), price to book (PB), price to sales (PS), and price to cash flow (PCF).
Company Overview
This paper will look at the financial reports of Imperial Oil (IMO). Imperial Oil is a Canadian oil company and the second largest in the country; its headquarters are in Calgary, Alberta. The company is a subsidiary of ExxonMobil, which has a 69.6 stake in Imperial Oil (Taylor, 2019). The company produces oil products such as bitumen, crude oil, and natural gas; they are a major refiner of petroleum products in Canada with extensive retail and supply networks. It supplies service stations under the brand name Esso.
Imperial Oil’s production mainly comes from Alberta Oil Sands and the Northwest Territories. Imperial Oil’s competitors include Conoco, Shell Canada, Cenovus Energy, Suncor, Canadian Natural, and Ultramar. All these competitors have revenues over $1 billion as of 2020 (Taylor, 2019). Several of Imperial Oil’s acquisitions and subsidiaries include Kendale Mobil Service in 2018, Santoprene in 2017, Jurong Aromatics in 2017, and InterOil Corporation in 2016.
Horizontal Analysis
Horizontal analysis is a methodology used to analyze a company’s financial metrics at a particular accounting period against the same company’s same metrics but from a different accounting period. This approach helps in analyzing historical trends. To measure the changes, one compares the current year’s results against a base year’s results (Easton et al., 2021). The objective is to determine an increase or a decrease. Percentages or absolute values may be used to perform horizontal analysis.
Consistency and comparability are vital components of generally accepted accounting principles (GAAP). Consistency is being able to accurately review a company’s financial reports over time since accounting procedures and applications have not changed (Laitinen, 2018). Comparability is being able to compare the financial results of different companies. Horizontal analysis enhances the company’s ability to review itself consistently and enables a company to juxtapose its reports against its competitors.
Horizontal analysis allows investors to infer the drivers of specific financial results over a certain period; it also helps spot growth patterns and trends such as seasonality. Using results from a horizontal analysis, one can assess changes in certain items and use this to predict the future (Easton et al., 2021). These predictions can be arrived at from income statements, balance sheets, and cash flow statements. From these documents, it is possible to paint a picture of the operational results and infer the drivers of the company’s efficiency and profitability.
Imperial Oil Horizontal Analysis
Table 1: Financial statement Imperial Oil(Imperial Oil Limited, 2020).
The following section will look at income statements and balance sheets posted by Imperial Oil for 2018 and 2019. The analysis will use YoY percentage changes for 2018 and 2019 (Imperial Oil Limited, 2020). From Imperial Oil’s financial results, there was a 20.05% increase in revenues at the end of the financial year 2018, owing to absolute figures increase from 29125 to 34964 CAD. At the end of the financial year 2019, revenues declined by 2.75%, caused by a decrease in absolute figures from 34964 to 34002. The increase in revenues in 2018 was reflected in net income figures, where the net income increased by an impressive 372.24%.
Although the net income declined by -4.93% in 2019, this was a low decline that was likely a correction after a remarkable increase the previous year. Total assets reduced by -0.35% in 2018 from 41601 CAD in 2017 to 41456 CAD in 2018. Considering that this was the year when they posted a >300% increase in net income, it shows that Imperial Oil had done a great job of converting assets to earnings. This impressive increase in net income in 2018 was also accompanied by a drop in total debt by 0.52%, further indicating better debt conversion into income.
The >300% increase in net income in 2018 is remarkable to the point that it almost seems like an anomaly when juxtaposed against Imperial’s historical data. It would be interesting to compare the result against its peers to examine whether it was an industry-wide phenomenon. Omv AG had a 170% increase in net income in 2018, Cenovus Energy Inc, on the other hand, had a 175% plunge in net income, while Suncor Energy had a 29.79% plunge in net income(30 Year Financials of Imperial Oil n.d.). Canadian Natural Resources Ltd reported a 2.73% increase in net income in 2018. From its peers’ data, it is evident that the results were not an industry-wide pattern, not even among Canadian competitors.
When one considers Imperial’s figures for the two years, it is tempting to conclude that Imperial Oil had a great year in 2018 due to sheer management prowess. However, going back a year earlier, in 2017, Imperial Oil had a net income of 490 million CAD and 1112 million CAD in 2015(Imperial Oil Limited, 2020). As it turns out, Imperial was recovering from an abysmal year in 2017 hence the impressive >300% rebound in 2018(Imperial Oil Limited, 2020). This case underscores the importance of considering multiple years when performing horizontal analysis; as in statistics, the bigger the sample, the more accurately one can deduce the underlying patterns.
Imperial Oil’s Current Ratio (Imperial Oil Limited, 2020)
Current ratio = current assets / current liabilities (Laitinen, 2018)
2019 current ratio = 2019 current assets /2019 current liabilities = 6329/ 4595 = 1.38
2018 current ratio = 2018 current assets / 2018 current liabilities = 5355 / 3955 = 1.35
The explanation for the above current ratios is that they are both comfortably above 1; this means that Imperial Oil would cover its short-term debt obligations. Moreover, the current ratio is not dramatically large, like 3, which would indicate that the company is underutilizing its assets.
Imperial Oils Quick Ratio (Imperial Oil Limited, 2020)
Current ratio = (current assets -inventory)/ current liabilities
2019 current ratio = 2019 current assets – inventory /2019 current liabilities = 6329-1296 / 4595 = 1.09
2018 current ratio = 2018 current assets-inventory / 2018 current liabilities = 5355-1297 / 4595 = 0.88
Imperial Oil had a quick ratio of 1.09 in 2019 and 0.88 in 2018. It shows that Imperial had 88 cents of quick assets to pay for every dollar of short-term liabilities. This is a safe ratio because, in the event of adverse circumstances, they still have inventories not included in calculating the ratio.
Imperial Oil does not have potential liquidity issues from the results of the quick ratio and current ratio. Current ratio analysis looks at how much existing debt a company has against its current assets. The current ratio includes inventory in its calculation. The problem with the current ratio is that inventory could require up to 90 days to sell. This is why a quick ratio is preferred over the current ratio to indicate a more dire hypothetical scenario. Even when considering the current ratio, Imperial Oil is in the safe zone because the lower of the two quick ratios, 0.88, indicates that they have 88 cents of current assets to offset every dollar of short-term debt, which is sufficient.
The utilization of resources varies with the industry; this is why companies are compared against their peers. From 30 Year Financials of Imperial Oil (n.d.), IMO had a current ratio of 1.38 for the financial year ended December 2019; Canadian Natural Resources had a current ratio of 0.5. Omv AG had a current ratio of 1.20 while Surgutneftegas was 7.97. Repsol SA had a current ratio of 0.79, Cenovus Energy’s was 1.3, while Gazprom had a current ratio of 1.16. Imperial Oil has a liquidity position in proximity with its peers, which is an indicator of financial health.
Imperial Oil’s Debt-to-equity Ratio (Imperial Oil Limited, 2020)
Debt to Equity = Total Debt / Total Stockholders’ Equity
= 5190 / 24276 = 0.21
2018
= 5180/ 24489 =0.21
In the financial year 2018, Imperial had a debt-to-equity ratio of 0.21, while in 2019, the debt-to-equity ratio remained the same at 0.21. The debt-to-equity ratio is a liquidity ratio that shows how much a company is financing its growth with debt. In both cases, the ratios are fractions indicating that Imperial Oil is not using much debt to fund its operations. Although the ratio depends on the industry, in its category, Imperial Oil has the second-lowest debt to equity ratio indicating good health.
Imperial Oil’s Asset-turnover Ratio (Imperial Oil Limited, 2020)
Asset Turnover = Revenue / Average Total Assets
2018
= Revenue (A: Dec. 2018) / ( (Total Assets (A: Dec. 2018 ) + Total Assets (A: Dec. 2017 )) / count )
= 34964 / ( (41456+41601 ) / 2 )
= 34964/ 41528.5
= 0.84
2019
Revenue (A: Dec. 2019) / ( (Total Assets (A: Dec. 2018 ) + Total Assets (A: Dec. 2019 )) / count )
= 34002/ ((42187+41456)/2)
= 0.81
Imperial Oil Interest Coverage Ratio (Imperial Oil Limited, 2020)
Interest coverage ratio is also known times interest earned ratio (TIE)
TIE = Operating Income (EBIT) / Interest Expense:
2018
TIE = Operating Income (EBIT): Dec 2018 / Interest Expense Dec 2018
= 3073/ -106
= 29
2019
TIE = Operating Income (EBIT): Dec 2019 / Interest Expense Dec 2019
= 2046/ -87
= 23
Imperial Oil’s interest coverage ratio indicates the ease with which a company can settle its interest expenses on outstanding debt. The higher the figure, the better the company’s position. In Imperial’s case, its interest coverage dropped from 2018 to 2019, which is a bad trend.
Imperial Oil’s Return on Assets (ROA) (Imperial Oil Limited, 2020)
2018
ROA % = Net Income (A: Dec. 2018 ) / ( (Total Assets (A: Dec. 2018 ) + Total Assets (A: Dec. 2017 )) / count )
= 2314 / ( (41456 + 41601) / 2 )
= 2314 / 41528.5
= 5.57% %
2019
ROA % = Net Income (A: Dec. 2019 ) / ( (Total Assets (A: Dec. 2018 ) + Total Assets (A: Dec. 2019 )) / count )
= 2200 / ( (41456 + 42187) / 2 )
= 1671 / 31444
= 5.26 %
Return on asset is a measure of net income against total assets over time.
Imperial Oil’s Return on Investment Ratio (ROE) (Imperial Oil Limited, 2020)
ROE % = Net Income attributable to Common Stockholders (Dec. 2018) / ((Total Stockholders’ Equity (Dec. 2017) + Total Stockholders’ Equity (Dec. 2018)) / count)
= 2314 / ((24489 + 24435) / 2)
= 9.45%
ROE % = Net Income attributable to Common Stockholders (Dec. 2019) /( (Total Stockholders’ Equity ( Dec. 2018 ) + Total Stockholders’ Equity ( Dec. 2019 )) / count )
= 2200 / ( (24489 + 24276 ) / 2 )
= 1671 / 18330
= 9%
ROE and ROA are both measures of how well a company is converting assets and equity to income. Imperial Oil had a good year in 2018, posting ROE and ROA of 9.45% and 5.57%, respectively (Imperial Oil Limited, 2020). The company’s ROE and ROA remained in the same range, posting results of 9% and 5.26%, respectively (Imperial Oil Limited, 2020). If anything, these results show stability; however, attractive companies for investors are those that improve their financial positions, not stagnate.
Recommendations
Imperial Oil had a favorable year in 2018 with a considerable increase in net income. Although the result seems to be a rebound after a slump in 2017, it seems they were able to maintain this in 2019 as the net income only dipped by 4.93%, which is unfavorable in absolute terms but not as negative relative to 2018 results (Imperial Oil Limited, 2020). The results indicate a fluctuating pattern for Imperial Oil. When analyzing whether to invest in Imperial or not, it would be prudent to assess the events of 2020 and the recovery of the oil industry in 2021.
The section will look at various ratios that inform whether Imperial Oil’s share price is fairly valued or not. The first ratio to look at is the price to earnings (PE) ratio. It is a financial ratio that compares a company’s share price to its earnings per share. As of March 11, 2021, IMO was trading at $25.2 (30 Year Financials of Imperial Oil n.d.). Imperial Oil’s diluted earnings per share for the trailing twelve months (TTM) for the financial year ended December 2020 was $ -1.93.
Therefore, since EPS was negative, PE was meaningless (30 Year Financials of Imperial Oil n.d.). It is not a surprise that IMO had negative EPS given the horrid year 2020 was from the COVID-19 pandemic. Looking at the EPS and PE for IMO without context would indicate that IMO is on a downward spiral; this is why one needs not make investment decisions by just looking at mere ratios. In the case of IMO, its PE should be looked at with the macro environment too.
Another ratio to look at is the price to book (PB) ratio. PB ratio compares the price of a company’s share against its book value per share. As of March 11, 2021, IMO trades at $22.2 per share (30 Year Financials of Imperial Oil n.d.). Imperial book value per share for the financial year ended December 2020 was $22.78 (30 Year Financials of Imperial Oil n.d.). Therefore, Imperial Oil’s PB ratio is 1.11 today. Over the last 13 years, Imperial Oil had the lowest PB ratio of 0.41 and the highest value of 3.81. Over the past 12 months, IMO’s book value per share grew at a rate of -10.60%, while it increased by -0.20% over the past three years (30 Year Financials of Imperial Oil n.d.).
Over the last five years, the average book value per share growth was 1.80%, while the same parameter grew by 8.5% over the past ten years. Over 13 years, book value per share grew at 20.40 per year. The lowest growth rate was -9.05, while the median annual growth was 6.25% (30 Year Financials of Imperial Oil n.d.). The results indicate decelerating growth over the past five years, which is a weakness.
Strength from the World Economy Perspective
A company’s financial ratios are important, but one should always analyze them in context. Imperial Oil seems to have had a bad year in 2020. Its ratios looked unfavorable but then factoring in the COVID-19 pandemic would ease the reservations one would be having about the company. It is vital to scan the global atmosphere and the politics that could affect specific industries. Canadian companies ship a lot of crude to the US. It is essential to consider the ramifications of the new Biden administration’s policies, such as the Keystone Pipeline’s cancellation (Saefong, 2021). Biden’s policies could favor Canadian crude if he could ban fracking in the US. Already, oil prices are rising from their 2020 lows, with Brent hitting $67 as of March 11, 2020(Saefong, 2021). The verdict for IMO is ‘buy’; it cannot get worse than 2020.
References
30-year financial data of Imperial Oil Ltd (Amex: IMO)—Gurufocus. Com. (n.d.). Web.
Easton, P. D., Halsey, R. F., & McAnally, M. L. (2021). Financial & managerial accounting for MBAs.
Imperial Oil Limited. (2020). 2019 annual report. Web.
Laitinen, E. K. (2018). Financial reporting: Long-term change of financial ratios. American Journal of Industrial and Business Management, 08(09), 1893–1927. Web.
Saefong, M. P. (2011). Here’s what Biden’s early actions mean for oil’s outlook. MarketWatch. Web.
Taylor, G. D. (2019). Imperial standard: Imperial Oil, Exxon, and the Canadian oil industry from 1880. University of Calgary Press.